You can find some economic phenomenon in the things you do every hour. At least I tell my students that. So when I recently learned that I have a malignant carcinoma, it was hard to resist the challenge. Here are a few things that came to mind:
I had recently gotten renewal notices for two hobby magazines I get. My wife does the bill paying, so I tossed them in her basket after checking the three-years-at-a-lower-rate box. But after hearing the pathologist’s report, I said, “Hey, Honey, just renew my magazines for one year instead of three.”
That reflexive decision demonstrates several things.
First, in efficient markets, people adjust decisions on how they use resources whenever they get new information. They often are rational in rejudging the new costs and benefits resulting from a changed situation.
Second, when the future is unknown, a person may make a subjective estimate of the probabilities of different possible outcomes actually happening.
Third, although the free-market purists beloved of contemporary libertarians believe that rationality dominates all decision making, research increasingly shows this often is not true. It would be just as human to decide to renew the magazines for as long a period as possible to affirm one’s deep-seated desire to survive the cancer. (This is not unlike people’s irrational reluctance to sell a stock that is going down.) Behavioral economics recognizes this complexity of human decision making.
When I was in a recovery room recently after minor initial surgery, a nurse asked, “On a scale from 1 to 10, how bad is your pain?” Use of such scales is helpful, but we still cannot measure human utility, i.e., pain or pleasure, on an objective scale.
Yes, I can say that the pain is worse in my throat than in my nose, just as I can say I prefer butterscotch malts to chocolate ones. I can say that the pain from this operation is less than when I had a hernia fixed 25 years ago. But we cannot objectively measure and determine that was a 4.8 and this a 2.7. Nor can we say that my subjective 4 is really worse than the 2 reported by the gentleman in a nearby bed. Perhaps he is just less of a wimp. Who knows?
This inability to measure human satisfaction in cardinal terms has profound implications. Jeremy Bentham, a 19th-century English economist, argued for utilitarianism, that economies should be structured to produce “the greatest good for the greatest number.” But if you cannot measure human pleasure or pain, that is a scientifically impossible task.
Economists believe in “diminishing marginal utility.” In other words, the extra satisfaction from the 25th spoonful of butterscotch malt is less than the addition satisfaction produced by the first. A pay raise of $100, from $10,000 to $10,100, produces greater additional happiness for a person than if that same person’s income advances by the same amount from $500,000 to $500,100.
But because we cannot compare between individuals, we don’t know scientifically that a change of $10 in Bill Gates’ income effects a smaller shift in total human satisfaction than $10 does for a disabled person living on Supplemental Security Income.
Some advocates of progressive income taxation and of poverty reduction programs argue that, because of diminishing marginal utility of money, the gain in satisfaction by a poor person from a $10 increase in SSI must be greater than the loss in satisfaction to Gates by paying $10 more in taxes. That may be true, but until we can measure satisfaction in cardinal rather than ordinal terms, it is impossible to prove.
Ironically, I was making some estate planning calculations when I found out I have cancer. My statistical life expectancy is now lower than it was a month ago. Should I now spend money faster, since I have less time in which to spend my accumulated savings? Or should I keep spending the same, since my income has not changed?
Five decades ago, there was a debate about how people react to temporary changes in income. Keynesians, who favored government changing taxes and government spending to manage booms and busts, argued that people will spend much of an extra payment from the government or from a reduction in taxes owed.
Milton Friedman and other opponents of Keynesianism argued, in the “permanent-income hypothesis,” that people make spending decisions based on their expectations of their incomes over their lifetimes. They will tend not to spend one-time windfalls. Thus stimulus programs are ineffective.
As for me, if my life expectancy is now shorter, wouldn’t Friedman find it rational for me to spend faster? But I really don’t plan to, perhaps because the bequest motive of providing for loved ones is strong.
How people form expectations of the future is another issue on which Keynesians and their intellectual opponents differed. Critics argued that Keynesian stimulus policies would work only if people have adaptive expectations, using past experience to predict the future.
I might, for example, assume that since doctors have always fixed my injuries and illnesses over the past 60 years, they will cure this carcinoma. But rational expectations, using all available information including medical knowledge, tell me that just because doctors could fix my hernia, hepatitis or acid reflux does not mean they can cure my cancer.
Rationality ultimately fades in importance at more fundamental levels, however. Rationality cannot explain “providence” or “grace.” Nevertheless, having repeatedly experienced these over 62 years, I know that in some ill-defined way, everything will be “all right” in the most important sense, regardless of the actual course of my illness. That is irrational, but it is highly important to my overall utility right now.